Australian investors love property, it has been a star performer. Most of us can't wait to buy that next investment property. A well structured investment property portfolio can be a great source of wealth creation. It will provide long term capital growth, give you tax savings today, and be a source of income in the future. It's no wonder that we love our bricks and mortar.
Over the past five years, more and more Aussies have been buying investment properties with their super funds. Many are using a special type of home loan designed for SMSFs. It's called a 'Limited Recourse Borrowing Arrangement' (LRBA),
Setting up a super loan requires an accountant and financial planner. They will help you adjust your super fund so it is set up for a SMSF mortgage. You will need a financial plan recommending you purchase a super property. You might also need to do a little tweaking of trust deeds before you are ready to go.
The market for SMSF lending is small, but is growing fast. In June 2009, the SMSF share of the mortgage market was just under $500 Million. By June 2014, this figure had grown more than 17 times and was over $8.5 Billion. Superannuation lending is one of the fastest growing sectors in the Australian mortgage industry. Australians are already using property as a way to build wealth for retirement. It makes sense that we'd want to use our superannuation for this. After all, the purpose of super, is to be our retirement savings vehicle.
Like all mortgages, you need to qualify for a SMSF Loan. The bank will assess a superannuation home loan based on:
- The income earned by the members of SMSF - 9.5% of your income goes into Superannuation as a compulsory employer SG contribution. This can be used to make loan repayments
- The potential rent from the property you purchase - Rent will be paid directly into your superannuation fund, and will help with loan repayments. Some banks will consider 100% of the rental income, while others might only consider 80%. They want to see that you can afford it with slightly less than expected rent. This is a risk management strategy
- Cash available in your SMSF for the property purchase - You will need to have enough funds in your SMSF to pay stamp duty, and a deposit of at least 20% (for residential investment property). You can not borrow more than 80% with an SMSF. 95% loans are available outside of super.
- Your SMSF Portfolio Value - After settlement, your SMSF will have cash and investments other than the property. The banks recognise that these investments will earn an income, and will consider it as part of the loan servicing calculations. To determine how much income your investments will generate, they apply a 'deeming rate', which is usually around 4%, of the value of your SMSF (excluding the new property).
Is it a good idea to borrow for a SMSF investment property?
If you ask the Financial System Inquiry, they'd say 'don't do it, it's a bad idea'. In their December report, they made a recommendation that all super lending be banned. They feel that the use of loans brings too much risk into superannuation. They fear that if people lose money from investing through SMSF Mortgages, then it will increase the burden on the Age Pension.
The FSI is definitely not a fan of SMSF lending and imply that this activity contradicts the intended purpose of superannuation. In their report, they say:
the objective for superannuation is a savings vehicle for retirement income, rather than a broader wealth management vehicle
Our answer to this, is that it depends on your circumstances. Like all investments, it's great for some, and terrible for others. Before you buy a Super Property, you should consider:
- Your Time to Retirement - By the time you retire, your aim is to have either paid the loan off completely, or at least have it down to a level where the rent alone can cover the loan repayments and all ongoing expenses. This is known as a cash flow positive property. If you plan to retire in 5 years, it's probably not a good idea to have a 30 year mortgage which can only be serviced if all your SG contributions and investment income is used.
- Time Frame of Your Investment - Superannuation should focus on long term buy and hold investments. If your plan is to invest in a 'hot suburb' and sell in 5 years at a big gain, then this should be done outside of superannuation.
- Your risk profile - Using debt increases the financial risk of any investment. The deal might look great today, but how would it look if the interest rate was 2% higher? Interest rates in Australia are currently at record lows, but that doesn't mean that they won't increase over the coming years. You need to understand and accept the risks before committing to a Super Loan
- The Portfolio Value of your SMSF - There are banks which allow you to spend all your funds and hold the property as a single asset in your SMSF. Others require you to have a minimum 'net tangible assets' (NTA), invested in other assets. If you are buying a property as a single asset, or are very close to the bank deemed minimum NTA, your SMSF might lack diversification. Put simply, you've got too many eggs in the property basket.
- The Property being recommended - Unlike standard residential mortgages, Super Loans can only be used to buy income producing assets. This means there are some restrictions. For example you can only buy a property which is ready for tenants. You can't not borrow to build a new property or even for renovations. Buying a property to 'fix up', works well, but is a bad idea with Super
The fact that your SMSF can qualify for a mortgage, does not mean that it's a good idea for you to get one. Make sure you are comfortable with all the risks, and have considered other options before you enter a long term loan agreement.
We hope this information was useful. This has is our streetonomic opinion on SMSF Loans. As always we'd love to hear from you. Keep sending emails and writing comments. We don't mind if it's opinions, feedback, or to ask for more detailed information.